Quick ratio (acid test)

The formula

• QR = (CA − L) / CL

CA is the current assets, L the inventory and CL the current liabilities. Taking the stock out leaves cash, bank balances and receivables: what can pay a bill without first finding a buyer.

A worked example

Current assets of 600,000 including 150,000 of inventory, against current liabilities of 300,000: QR = (600,000 − 150,000) / 300,000 = 1.5, or 150% as a percentage. The current ratio of the same company is 600,000 / 300,000 = 2; the half point between them is the stock.

Why the stock is left out

Inventory becomes money only when it is sold, at a price that is not the book value and on a date that is not known. A warehouse of last season’s goods can cover a current ratio and pay no invoice. The quick ratio asks the stricter question, which is why it is also called the acid test; the cash ratio is stricter still and keeps only the money in hand.

Reading the number

A quick ratio of 1 means the receivables and the cash alone cover the year’s debts. A business that sells for cash, such as a restaurant, holds few receivables and runs on a lower figure; a wholesaler with sixty days of invoices outstanding needs more. As with every balance-sheet ratio, the trend over years says more than one date.

Common mistakes

• Leaving the inventory in. That is the current ratio.
• Counting prepaid expenses as quick assets. Rent paid in advance will not pay a supplier.
• Forgetting the condition in the card. The ratio times the liabilities cannot exceed the current assets; the card refuses an inventory that would be negative.

Frequently asked questions